The eurozone crisis intensified on Friday when Spain and Italy were downgraded by the ratings agency Fitch, heightening fears over the health of Europe's banks.

Fitch's move came at the end of a day which had already seen 12 UK banks and building societies downgraded by the rival agency Moody's and amid speculation about co-ordinated European action to bolster the finances of the continent's banks by next weekend.

The euro fell against most major currencies, piling fresh pressure on European politicians to restore confidence in the single currency. Germany's Angela Merkel said Europe needed to find a solution for its banks by 17 October. Analysts from Capital Economics estimate the total financial package may top €200bn (£172bn).

Merkel and Nicolas Sarkozy of France are due to meet in Berlin on Sunday to discuss the crisis, with bank recapitalisation expected to be at the heart of their negotiations.

George Osborne attempted to distance UK banks from the crisis, despite speculation that there might need to be a fresh capital injection into British institutions, particularly Royal Bank of Scotland. He said: "People ask me how are you going to avoid Britain and the British taxpayer bailing out banks in the future. This government is taking steps to do that … I'm confident British banks are well capitalised, they are liquid, they are not experiencing the kinds of problems some of the banks in the eurozone are experiencing at the moment."

Shares in RBS and Lloyds, both bailed out in October 2008, were the biggest fallers in the FTSE 100 even though the Moody's downgrade was widely expected. The Treasury has prepared contingency plans if Greece is forced to default, and has looked at the scale of the problems facing RBS, but it denies it has been looking at full nationalisation.

Lord Oakeshott, the former Liberal Democrat Treasury spokesman in the Lords who resigned over the so-called Project Merlin deal on lending and bonuses, called for the taxpayer to take 100% control of RBS to get lending going again.

"This week George Osborne has admitted Project Merlin has failed – RBS is the worse culprit, starving viable small businesses of the credit they need to grow.

"They can't wait for the Treasury to dream up fancy new financial structures – they just want them to pull the stuck lending levers now, starting with RBS," he said.

Osborne this week raised the idea of "credit easing" to try to boost lending to small businesses.

Moody's said the downgrade of the UK's banks was necessary because the government was stepping back from bailing out banks when they ran into difficulty. "The downgrades do not reflect a deterioration in the financial strength of the banking system or that of the government," Moody's said.

It was announced this week that GDP was revised down to 0.1% in the second quarter adding to pressure on Osborne to come up with a "Plan B".

Cabinet supporters of a more interventionist economic policy are now considering a major housing construction programme as the next step after QE. Key figures such as Oliver Letwin, David Cameron's key policy adviser based in the Cabinet office, have been working behind the scenes since the summer on the packages announced this week, but they also recognise far more needs to be done to promote growth.

Ministers are looking at putting a limit on how long construction firms can hoard land on which they have permission to build. Firms could be required to release the land for someone else to build on the property.

A new housing programme will be outlined by the coalition in November, and it is viewed as the next major practical step the government can take to boost the economy – apart from pushing for a settlement to the euro crisis

They are confident they can overcome resistance from the countryside lobby by making relatively small changes to the new national planning policy framework.

In a complex rating action, the agency upped the ratings on the basis of stand-alone financial strength for five institutions – Co-op, Nationwide, Santander and Yorkshire and Principality building societies.Spain, which was stripped of its top notch triple A rating in 2010, has now been cut twice by Fitch, which is concerned about the eurozone crisis. The cut to Italy's rating followed moves by rival agencies in recent days while Fitch also warned it might down grade Portugal.

European markets had closed by the time of Fitch's announcement on Spain and Italy but the news of the downgrades took the heat out of a rally on Wall Street, which had been buoyed by better than expected employment numbers. Bank of America and Goldman Sachs were among those losing 4% or more amid concern about their exposure to the eurozone.